Barron's Streetwise - General Electric CEO Larry Culp's Breakup Endgame

Episode Date: July 14, 2023

Plus, this meme stock rally doesn't look particularly meme-y.  Learn more about your ad choices. Visit megaphone.fm/adchoices

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Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. If you look at what we've done over the last five years, right, $100 billion plus of the leveraging, we weathered the pandemic, we're going through this separation, not to mention the first time we brought in an outside chairman CEO in the company's history. If the next five years we have none of that to work through, but can be wholly focused on the businesses so that we're even better positioned to take advantage of those tailwinds, I think

we're going to be in great shape. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard, that's Larry Culp. He's the CEO of General Electric, which is undergoing some profound changes at the moment and whose stock is up more than 70% year to date. We're going to talk about that and we'll say a few words about the broad stock market and earnings season and meme stocks. stock market and earning season and meme stocks. Listening in is our audio producer, Meta. Hi, Meta.

Hi, Jack. We were talking about some gloomy things. There's been a lot of flooding around here. There has been earlier, we had a lot of smoke blowing through the air from wildfires. It's getting nuts. And you had found a bit of cheerful, I don't know, is it cheerful news?

You had found a picker-upper in browsing the headlines there. What do you have for us? Well, you tell me. The headline is, she steals surfboards by the seashore. She's a sea otter. And then it goes, California wildlife officials are hoping to apprehend a five-year-old sea otter who has a knack for riding the waves after committing longboard larceny. Okay, first of all, there's a plot twist right in the headline. I like that. There's an otter thief slash surfer. I am wondering, are there accomplices? Because it's a longboard and an otter is kind of a short thief. So are we talking about a band of otters and this is a ringleader?

What else have you learned? I think she works alone. Okay. And there's a picture here with an otter on top of an actual surfboard. And the caption reads, another surfboard is commandeered. That's great art to go with the story. But I'm not sure it's all good news. Oh.

Yeah. You sure you want to hear the rest? Give me three words and I'll tell you whether I want to know more. Could bite finger. I got to stop you there. It's getting too dark. Let's move on to the stock market, which I think is unambiguous good news. The S&P 500 is up about 16% year to date, although could bite finger might be a good subhead there too.

The index is trading at about 20 times underlying earnings. That's pretty expensive. We happen to be on the cusp of receiving quarterly reports that will count toward the second quarter earnings season. So maybe there's going to be rip roaring growth. second quarter earnings season. So maybe there's going to be rip-roaring growth. But if you look at the consensus expectation, analysts expect earnings for the S&P 500 companies to decline 9% versus a year ago. They expect flat sales and shrinking margins. Goldman Sachs says that investors should watch for four factors in the upcoming earnings reports. The first one is margins. Companies have been hit by inflation.

Margins are expected to bottom this quarter and then improve thereafter. The second one is credit. We're going to hear first from banks. Were they hurt by the banking stress that we saw earlier this year and the effect on the economy? And how were they hurt? And what do they say about loan losses? The third thing is artificial intelligence. Absolutely everyone is talking about it. The

timing of profits from it is uncertain. So what do companies say there? And the fourth is the consumer. Everyone is wondering how strong the consumer is at the moment. Results from consumer discretionary companies and staples will give us an idea. There are a couple of other things that investors are apprehensive about. One is the Federal Reserve and rate hikes. I know that's old news. The Fed has already raised interest rates a lot. We just got a fresh reading on inflation. The year over year inflation rate was 3%. That's cooler than we've seen. So shouldn't those fears about rate hikes be behind us? Well, maybe, but the effects of those rate hikes, they don't happen immediately. Sometimes they take a while to play out. Here's Barry Gill, head of investments at UBS Asset Management.

It takes a long time for the impact of higher rates to bite. The Fed is unequivocally trying to get inflation under control. Using interest rates is a crude instrument. It's a blunt instrument. And it's very unlikely that they will be able to sort of land the plane smoothly. And so what you've seen over the course of the last 12 months, I'm going to paraphrase Warren Buffett, it's only when the tide goes out that you see who's been swimming nude. You've come across a few nude bathers in the last 12 months. And the question is, has this change in the interest rate environment been enough? Have we gone through the full exposure of this? I doubt it. This is a massive change in the cost of capital. It is very unlikely that there hasn't been bad behavior, loose behavior, loose capital allocation decisions, both in the markets and in the real economy. And I think that that's probably going to come home to roost in 2024. Okay, so we have to wait a little while to see the full effect of those raid hikes, and who's been swimming

nude, and whether that lady otter stole their surfboard. But there's another concern, and it's not easy to talk about. I mean, it's hard to pronounce. It's market breadth. Breadth. Breadth.

Right, not breath. Not like breathing breath it's a very unelegant word yeah it's not a good word someone come up with a better word to mean what breath means we're talking about the seven or so largest companies in the s&p 500 and how they have dominated returns so far this year let me read read them off for you, starting with the biggest. Apple is up 45% this year. Microsoft up 39%. Alphabet up 33%. Amazon, 53%.

Nvidia, 190%. Tesla, 119%. And meta platforms, 148%. So what you'd really like to see is broader participation, some of the smaller companies rising too. But maybe you don't want that participation to get too broad. Meme stocks are suddenly running again, and the investment firm BTIG takes that as a sign that investors should be cautious about the direction of the stock market in the weeks ahead. It put out a report this past week titled, Return of the Memes is a Red Flag. And it points out that meme stocks rose 10% in just a three-day period, and that consumer staples during that

period were down 1.6%. And it compares that with periods in the past when meme stocks have done that much better than staples. And it finds that in the in the past when meme stocks have done that much better than staples. And it finds that in the subsequent weeks, the stock market tends to decline. We're not talking about massive declines here. This is more of a technical note. It's more for someone who's a short-term trader than someone thinking about the next five or 10 years for their money. Here's what struck me about the meme analysis.

the next five or 10 years for their money. Here's what struck me about the meme analysis. If we're talking about what meme stocks are doing in general, that means that we have figured out a way to define what a meme stock is and to quantify what they're doing as a class. There must be a meme index and there is. And there's an index fund attached to it. It's called the Roundhill Meme ETF. The ticker is Meme.

Meta, when those meme stocks first started to take off, like GameStop and all those, I had people ask me what a meme is. Like people who don't spend their days on, you know, Twitter trading pictures of, you know, cats or whatever. They don't necessarily know that word. It's a relatively new word. How would you define a meme for someone? It's like a joke on the internet that went viral, maybe? Yeah. I think of it as like there's a picture and it gets traded around the internet and it has a different caption each time and you put your own little joke on it. And you have to be in the know to find it funny. And that's part of the allure.

It's like one of those, I get it jokes, you know? Yeah. And I think I only get about half of them. So meme stocks are not like that. There are not slight variations on each one. It's just a stock that takes off, but there is a jokiness to it. And I want to be careful about how I say this. If you take a company like GameStop, there's nothing jokey about that company. It's a chain of retail stores. There are people working there trying to do a good job. There are customers who enjoy GameStop. The joke of the stock run of GameStop was how far the stock became detached from the

economic realities of the business and the fact that it had been heavily shorted and this band of people who were buying it felt like they were really sticking it to these investors who had shorted the company. The same is true of AMC Entertainment, the theater company. I like going to the movies. I wish that company well. But we're at a moment where people aren't sure about the future of the movie theater business. And for that stock to suddenly take off and rocket higher, there's a certain irony involved there. And for that stock to suddenly take off and rocket higher, there's a certain irony involved there. And then there are some that are sort of more obvious jokes. There was a while there where Zoom took off, not the Zoom that we use for video calling,

the wrong Zoom, a company that had nothing to do with that, that happened to have the same name at a moment when video conferencing was taking off, the wrong stock took off. That's funny. And when people saw that it was happening, they bought the stock, the stock went up more, I guess, which is even funnier. And there was a moment when a company that held some of the assets of the former blockbuster video, that took off. Okay, so these are meme stocks. But if you want to make a stock index, you have to measure something, you have to quantify. The S&P 500, that's the 500 largest U.S. companies by stock market value. There are rules for selecting those companies.

So what are the rules for telling whether something is ironic? Well, there's not a rule for that. There are different rules used to select the stocks for the meme index and ETF. It looks for companies that have had a lot of mentions on social media and ones that have been heavily bet against, ones with high short interest, as it's called, as a percentage of the float or the available shares. And the portfolio makes changes monthly. And it turns out when you screen for stocks using those two factors, you get some of the usual suspects of that group of high flyers.

I'm looking at the recent list of holdings for the ETF and GameStop is in there. AMC Entertainment is in there. BlackBerry is in there. The top holding in the ETF and a stock that has really rocketed higher in recent days is Rivian Automotive. That stock has doubled in short order to about 25 bucks a share, but it's down from well over $100. Investors have been cheered by some of the news on production, but the company appears to still be years away from profitability. Riot Platforms was recently the second biggest holding in the ETF. That's involved in cryptocurrency mining, and that has been a big mover recently as well. So has Carvana, which is the third biggest holding.

That one is in the used car business. When companies that are so different like this are all moving together, it suggests to me, maybe this is a meme rally. It seems to be the thing that these companies have in common. But one thing that's unusual is that there are some names among the holdings of this ETF that you wouldn't necessarily think of as meme stocks. Delta Airlines is in there. That stock has been a good performer since spring, but it hasn't had the same jump within the recent few days as the others. And I don't think of Delta as a meme stock at all. I think of it as maybe the strongest of the legacy airlines in the US in terms of financial performance. It's solidly profitable. It produces cash. I guess there's a running joke about how airlines

in general are poor long-term performers. We're waiting to see whether the business has changed at all, whether it's going to be more profitable over the long term. But that to me is there's nothing necessarily so ironic about Delta stock doing well. But again, the portfolio uses this screening mechanism. So it fits the criteria of companies that people are talking about on social media and that lots of investors are betting against. What do you think, Meta? Delta, meme stock or not a meme stock? I wouldn't say a meme stock. It sounds just like a stock. Definitely not a meme stock. Okay. What about Carnival, the cruise company, Carnival? I wouldn't think a meme stock either.

Not a meme stock. Big company, profitable. Apart from the pandemic where obviously cruise lines were among the hardest hit these are this is an industry that was uh prosperous and had a bright future and so you know carnival is on the on the comeback um maybe the stock has been volatile because of that rapid swing in profits but i wouldn't characterize that as a meme stock what about walgreens boots alliance that's the drug chain. I don't know if you get further from a meme stock than that. Yeah, not a meme stock, but also on the list. My point here, Madda, what was my point? Did I have a point? Seems like I should be leading to

a point. I think I just find it curious or unusual about the effort to define meme stocks and how difficult it is and the fact that these other companies popped up in this index. And I wonder what these companies would think about that. No one wants to be known as a meme stock. No one wants for it to be ironic that their stock is going up. And I don't think it's ironic that these stocks are going up. Was that my point? I think you had a bigger point about the market. Okay, well, here's one point. I'm not entirely convinced this recent run-up for meme stocks is a sign that the market is about to tank.

I think it's fluffy and frivolous and maybe speculative behavior. I think stocks look expensive. If you're not sure, I think the good news is if you're someone who you don't want to move out of stocks wholesale, but maybe you want to reduce your stock exposure a little bit, the returns for doing that are better than they've been in quite some time. Let's go back to Barry from UBS. For the first time in, what is it, 15, 16 years? It's a long time since you've had five plus percent interest rates on money market funds. So cash is now a viable alternative in your portfolio. And given the level of uncertainty, the fact that that's there, it makes it very, very attractive. And by nature, because of the

environment that we've been in for so long, investors have tended to be overweight, these very long duration securities growth equities, and they've tended to be overweight, very high quality fixed income instruments that also tend to be long duration. Jeremy Grantham And I don't think that we're at the point where that makes a lot of sense. I think there's too much potential volatility manifesting itself. It's been one way traffic into the US market for a very long period of time, but there's lots of interesting stuff going on in Japan and emerging markets as well. So I think you're going to have to be a lot more granular

in how you're allocating capital now and not simply thinking about this 60-40 mindset. Barry's saying that if you're worried about U.S. stocks and you want to raise some cash, 5% on money market funds looks pretty good. And meanwhile, make sure you have enough exposure to develop markets overseas, which look cheaper. Thank you, Barry. Let's take a quick break and we'll be back with GE CEO Larry Culp. Welcome back. What does General Electric do? If you'd asked that question 130 years ago, the answer would have been straightforward. There's that guy Thomas Edison with the light bulb stuff, and he had a company, and it joined together with two others, and they formed Edison General Electric. They did electric stuff and that came

in handy during the age of electrification. The first commercial power station, indoor lighting, an electric locomotive. The company has been at the heart of a lot of innovations over the years. It had a hand in x-ray machines, radio broadcast, home appliances, and TV. Toaster ovens. Definitely toaster ovens. Now in 1981, a man named Jack Welch took over the company. His nickname was Neutron Jack. He was big on efficiency and layoffs, and the nickname suggested that, like a neutron bomb, he could eliminate people while hanging on to assets. That's apparently how neutron bombs work.

It's pretty grim now that I think about it. Kind of depressing. Might have shot at another appliance. Microwave! There we go. That's good. That's good. Okay, well, Jack Welch got the company into show business.

He got the company into high finance, began making money in a lot of different ways, really turned GE into a true conglomerate and was known for his aggressive earnings targets. But eventually the company just got too big, too complicated, too troubled. GE was particularly hard hit by the 2008 financial crisis. Those high finance assets that have been sources of easy earnings in past years were weighing the company down. And GE has really been a turnaround in progress ever since. The focus has been on what the company can sell and spin off and how to get back to its manufacturing roots. The company by now is out of show business. It's mostly out of high finance and it's out of the appliance business. Sorry Meta.

Also in 2018 the company appointed Larry Culp as CEO. Larry does not have any jazzy nuclear nicknames to my knowledge. He does have a reputation as the guy who ran the industrial company Danaher for many years and produced great returns for shareholders. Larry's plan for GE is basically to split the company in three. And part of that is already done. In January, GE spun off GE Healthcare Technologies. That trades under the ticker GEHC. There are two pieces left and these will soon be separated too.

The first one is called GE Aerospace. It makes engines and other components both for commercial aircraft and for defense. Then there's GE Vernova and that's in the power business, both the traditional power business and the green power business. For example, they make both gas turbines and wind turbines. Investors have been responding favorably to these changes. GE stock is outperforming this year. I had a chance recently to speak with Larry in connection with the Barron's top CEO's issue. He had just come back from a big air show in Paris. Let's pick up the conversation. And you are fresh back from the Paris air show. You're really going to be focused on the aerospace

part of the business going forward. I hear every year about the Paris air show. That's the place where people make big announcements about who's buying planes and stuff like that. Describe to me the importance of this air show, who does what there and what did you? And what did you hear? And what did you announce this year? What should we know about your participation there? Well, Jack, that's exactly right relative to my own role. I have two responsibilities today, still chairman and CEO of GE. I'm also doing double duty as CEO of GE Aerospace. And when Vernova spins early next year, my two roles will effectively

become one and I'll run the go forward GE Aerospace business. But we had a heck of a week in Paris. And this was a show where there were a number of big announcements, primarily with the airframers, both Boeing and Airbus. We count each of them as excellent partners and customers. I think for us, both customer and investor interest was focused first on our LEAP engine. This is the engine that powers the 737 MAX of Boeing, has the better part of 60% market share on the A320, A321 NEO family at Airbus. And as we ramp here, both in terms of the airline's use of the engines as they recover post-pandemic, and as the airframers ramp, people want more of those engines, more than we can make. So we're working hard to ramp for them, but also want to make sure that we continue to improve the technical capabilities of the engine. And we talked a good bit about the

technical roadmap that is underway to continue to make the leap, the premier narrowbody engine in the world. So the Paris Air Show is a visual spectacle because there are a lot of toys on the tarmac there at Bourget. But what we were excited about was the fact that we have such an enviable position in the fleet today. But also, there was a lot of conversation around our RISE technologies, which is really a suite of technical investments that we're making with an eye toward a more sustainable engine architecture in the 2030s. And again, customers, investors, a good bit of the French government, of course, was there as well, all took keen interest in the program update that we shared with attendees.

What does that mean, a sustainable engine architecture? When I think about a company that makes aircraft engines, I think, well, the customers must want as good a fuel efficiency as they can get and reliability. And I don't have trouble thinking of what else to add to the list, but there must be other things that they want. So what is this architecture? How is this going to satisfy customer needs? Well, Jack, you're exactly right. In many respects, we've been on the sustainability track for decades.

You look back over the last 20 or 30 years, each success of GE engine has improved efficiency by about 1% per year. Now, it tends to be a step function improvement when new engines are launched. But over time, the cumulative effect has been significant. Now, as we go forward, we may talk less about efficiency. We may talk more about sustainability, emissions reductions, and the like, but it's the same game. What we're doing with our RISE program is really moving forward with a new engine architecture. Think a turboprop open fan that allows us to have greater propulsion efficiency. We think there's a step function, call it 20% improvement in the

efficiency of that engine. Now, the airlines will love the cost savings as a result of RISE, and we know that regulators, governments, and the general public will love the sustainability impact. That's really what we're talking about, in addition to a whole host of other things like SAF or sustainable aviation fuels, which are part of the industry's arsenal to tackle our 2050 goals. What are going to be the keys to growing this business? I mean, the strategy must be remarkably different now that you're focusing at some point in the near future on one specific piece of the business. I guess it's growth and air travel. I guess it's taking market share from competitors. What do you think about when you think about the keys to your long-term success in this business where you need to invest and so forth?

Well, Jack, in many respects, I think what happens is that by and large, the strategy at GE Aerospace, as well as the other two businesses, doesn't really change. The teams just get to focus wholly on those opportunities, those customers, those markets, competitors, and the like, right? There'll be less of a conversation about collaboration across the company. There'll be probably less attention paid to headquarters per se. And it's really all about the business in all three instances. And I think that was what the board had top of mind when we launched this program back in the fall of 21. And as we go forward at GE Aerospace, there's no question that we want to continue our technological leadership, both around efficiency or sustainability,

in addition to safety, quality, durability, and trust. That's something that you can't necessarily generate overnight, but it's something that GE Aerospace has done really over time. As we move forward, we know people, particularly post-pandemic, want to travel. We know as markets like Asia Pacific continue to grow, there's going to be more demand. There's a good bit of talk at the Paris Air Show about the large orders coming out of India. One was announced by Indigo Airlines, Air India announced a similarly large order earlier this year. So if we continue to lead from a product perspective, if the market continues to grow and we can support our customers, and remember, this is a business where 70% of our revenues and even more of our free cash and our profit comes in the

aftermarket, comes from services. If we can continue to improve and perform in that regard, this business will grow. And how we then in turn think about capital allocation will be, I think, at the top of the board agenda. But there'll be a lot of, I think, ways for us to reinvest in the business, return money to shareholders, and generate superior returns. Let's talk about shareholders. What type of investor do you think that this future GE, this aerospace core will appeal to? Sometimes when companies are breaking up, they talk about catering to different investors. This part of the business will be good for the growth investor. This part is for the investor who wants income. What's the type of investor who might be interested in the aerospace business? Well, Jack, you're spot on. And I think one of the most decisive pages that we reviewed as a board back in the summer and fall of 21 was how well owned or how under owned we were by investors focused in health care, aerospace and energy.

in healthcare, aerospace, and energy. We knew that given some of the recent challenges in the business, we weren't necessarily the top of every portfolio manager's list. But what was really telling is that there were PMs in each of those three market sectors who were putting together portfolios of market leaders, simply seeking exposure to those verticals, who were way underweight GE, healthcare, aerospace, and Vrnova. So part of what we think that we're going to do is position the businesses as pure plays. So those portfolio managers who want to play the aerospace recovery have no better option than GE aerospace. Likewise in healthcare, and we've already seen that as GE healthcare has traded as an independent company here since the first week in January.

We know the same will hold at GE Vranova. There are very few pure plays at scale with respect to the energy transition. If you want exposure to gas, to onshore wind, offshore wind, to grid, to small modular reactors in the nuclear space. They're very few places to go. GE Vernova is going to be a great option for investors with that in mind. I talk with a lot of CEOs that most of them end up in charge of more stuff as time goes on. The change you're making at GE, investors are responding favorably to it. You're going to be in charge of less stuff. Are you going to have enough to keep you busy going forward? And take this opportunity to tell me about it. Is there

anything that I neglected to ask you about the future of this business you think is important for investors to know? Jack, I think we hit on all the high points here. Again, each business has tremendous secular tailwinds. They are market leaders. And if you look at what we've done over the last five years, right, $100 billion plus of deleveraging, we weathered the pandemic. We're going through this separation, not to mention the first time we brought in an outside chairman, CEO in the company's history. If the next five years we have none of that to work through, but can be wholly focused on the businesses so that we're even better positioned to take advantage of those tailwinds.

I think we're going to be in great shape. I welcome the opportunity to have a little less to do. Right. I don't mind having less debt to to whittle down. I'll still be a shareholder in the other two businesses. I am on the board at health care. But as we go forward, I'm looking forward to spending more time at Aerospace. It's a great business in many respects. And frankly, you have to go back to, I think, the early 90s, Jack, when I simply had responsibility for one single P&L, and that holds a lot of appeal.

holds a lot of appeal. Thank you, Larry. And thank you, Barry. And a shout out to Harry Carey and to Mary Mary Quite Contrary. Thank you all for listening. Meta Lutsoft is our producer. Tumble dryer. Nope, still no. Appliance business sold to a China-based company called Hire for $5.6 billion in 2016. But I'm past the part where we're doing facty stuff. This is my outro and goodbye. Subscribe to the podcast on Apple podcast, Spotify, or wherever you listen to podcasts. And if you listen on Apple,

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